UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Commission File Number: 001-38065

PCSB Financial Corporation

(Exact Name of Registrant as Specified in its Charter)

Maryland	81-4710738
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2651 Strang Blvd, Suite 100 Yorktown Heights, NY	10598
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (914) 248-7272

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	Small reporting company	☐
		Emerging growth company	☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for completing with any or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

18,348,994 shares of the Registrant’s common stock, par value $0.01 per share, were issued and outstanding as of November 9, 2018.

Table of Contents

		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	2
	Consolidated Balance Sheets	2
	Consolidated Statements of Operations	3
	Consolidated Statements of Comprehensive Income	4
	Consolidated Statements of Changes in Shareholders’ Equity	5
	Consolidated Statements of Cash Flows	6
	Notes to Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	38
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	39
Item 1A.	Risk Factors	39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Mine Safety Disclosures	39
Item 5.	Other Information	39
Item 6.	Exhibits	39
Signatures		40

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

PCSB Financial Corporation and Subsidiaries

Consolidated Balance Sheets (unaudited)

(amounts in thousands, except share data)

	September 30,			June 30,
	2018			2018
ASSETS
Cash and due from banks	$	66,039		$	60,684
Federal funds sold		2,284			1,461
Total cash and cash equivalents		68,323			62,145
Held to maturity debt securities, at amortized cost (fair value of    $328,962 and $343,188, respectively)		340,208			353,183
Available for sale debt securities, at fair value		101,540			105,472
Total investment securities		441,748			458,655
Loans receivable, net of allowance for loan losses of $4,959 and    $4,904, respectively		905,093			902,336
Accrued interest receivable		4,747			4,358
Federal Home Loan Bank stock		2,049			2,050
Premises and equipment, net		11,546			11,598
Deferred tax asset, net		2,495			2,622
Foreclosed real estate		754			460
Bank-owned life insurance		23,887			23,747
Goodwill		6,106			6,106
Other intangible assets		405			433
Other assets		7,342			5,677
Total assets	$	1,474,495		$	1,480,187
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing deposits	$	1,022,096		$	1,025,574
Non-interest bearing deposits		131,025			131,883
Total deposits		1,153,121			1,157,457
Mortgage escrow funds		4,981			8,803
Advances from Federal Home Loan Bank		18,810			18,841
Other liabilities		7,706			7,527
Total liabilities		1,184,618			1,192,628
Commitments and contingencies (Notes 1 and 2)		-			-
Preferred stock ($0.01 par value, 10,000,000 shares authorized, no shares    issued or outstanding as of September 30, 2018 and June 30, 2018)		-			-
Common stock ($0.01 par value, 200,000,000 shares authorized,    18,165,110 shares issued and outstanding as of September 30, 2018 and    June 30, 2018)		182			182
Additional paid in capital		179,294			179,045
Retained earnings		130,189			128,365
Unearned compensation - ESOP		(12,839	)		(13,083	)
Accumulated other comprehensive loss, net of income taxes		(6,949	)		(6,950	)
Total shareholders' equity		289,877			287,559
Total liabilities and shareholders' equity	$	1,474,495		$	1,480,187

See accompanying notes to the consolidated financial statements (unaudited)

2

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Operations (unaudited)

(amounts in thousands, except share and per share data)

	Three Months Ended September 30,
	2018		2017
Interest and dividend income
Loans receivable	$	9,898	$	8,818
Investment securities		2,366		2,245
Federal funds and other		345		234
Total interest and dividend income		12,609		11,297
Interest expense
Deposits		2,056		1,267
FHLB advances		89		154
Total interest expense		2,145		1,421
Net interest income		10,464		9,876
Provision for loan losses		58		135
Net interest income after provision for loan losses		10,406		9,741
Noninterest income
Fees and service charges		418		381
Bank-owned life insurance		140		149
Gain on sale of securities, net		-		173
Other		83		11
Total noninterest income		641		714
Noninterest expense
Salaries and employee benefits		5,140		4,860
Occupancy and equipment		1,241		1,282
Communicating and data processing		472		491
Professional fees		369		413
Postage, printing, stationary and supplies		138		132
FDIC assessment		93		78
Advertising		87		165
Amortization of intangible assets		28		32
Other operating expenses		440		441
Total noninterest expense		8,008		7,894
Net income before income tax expense		3,039		2,561
Income tax expense		710		805
Net income	$	2,329	$	1,756
Earnings per common share:
Basic	$	0.14	$	0.10
Diluted	$	0.14	$	0.10
Weighted average common shares outstanding - basic and diluted		16,869,100		16,756,447

See accompanying notes to the consolidated financial statements (unaudited)

3

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income (unaudited)

(amounts in thousands)

	Three Months Ended September 30,
	2018			2017
Net income	$	2,329		$	1,756
Other comprehensive (loss) income:
Unrealized gains (losses) on available for sale securities:
Net change in unrealized gains/losses before reclassification adjustment		(153	)		(213	)
Reclassification adjustment for gains realized in net income		-			(139	)
Net change in unrealized gains/losses		(153	)		(352	)
Tax effect		32			120
Net of tax		(121	)		(232	)
Defined benefit pension plan:
Net gain (loss) arising during the period		-			-
Reclassification adjustment for amortization of prior service cost and net gain (loss) included in net periodic pension cost		145			181
Tax effect		(30	)		(62	)
Net of tax		115			119
Supplemental retirement plans:
Reclassification adjustment for amortization of prior service cost and net gain included in net periodic pension cost		9			8
Tax effect		(2	)		(2	)
Net of tax		7			6
Total other comprehensive (loss) income		1			(107	)
Comprehensive income	$	2,330		$	1,649

See accompanying notes to the consolidated financial statements (unaudited)

4

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity (unaudited)

(amounts in thousands, except share data)

														Accumulated
					Additional						Unallocated			Other
	Number of		Common		Paid-In			Retained			Common Stock			Comprehensive			Total
	Shares		Stock		Capital			Earnings			of ESOP			Loss			Equity
Balance at July 1, 2018		18,165,110	$	182	$	179,045		$	128,365		$	(13,083	)	$	(6,950	)	$	287,559
Net income		-		-		-			2,329			-			-			2,329
Other comprehensive income		-		-		-			-			-			1			1
Common stock dividends declared ($0.03 per share)		-		-		-			(505	)		-			-			(505	)
ESOP shares committed to be released (24,419 shares)		-		-		249			-			244			-			493
Balance at September 30, 2018		18,165,110	$	182	$	179,294		$	130,189		$	(12,839	)	$	(6,949	)	$	289,877
Balance at July 1, 2017		18,165,110	$	182	$	177,993		$	121,148		$	(14,262	)	$	(5,215	)	$	279,846
Net income		-		-		-			1,756			-			-			1,756
Other comprehensive loss		-		-		-			-			-			(107	)		(107	)
Issuance of common stock (1)		-		-		(17	)		-			-			-			(17	)
ESOP shares committed to be released (34,953 shares)		-		-	258				-		349				-			607
Balance at September 30, 2017		18,165,110	$	182	$	178,234		$	122,904		$	(13,913	)	$	(5,322	)	$	282,085
(1) Represents costs incurred in association with the Company's initial public offering completed in the prior period.

See accompanying notes to the consolidated financial statements (unaudited)

5

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

(amounts in thousands)

	Three Months Ended September 30,
	2018			2017
OPERATING ACTIVITIES
Net income	$	2,329		$	1,756
Adjustments to reconcile net income to net cash provided by    operating activities:
Provision for loan loss		58			135
Depreciation and amortization		299			387
Amortization of net premiums on securities and net deferred loan    origination costs		482			383
Net increase in accrued interest receivable		(389	)		(485	)
Net gains on sales of securities		-			(173	)
ESOP Compensation		493			607
Earnings from cash surrender value of BOLI		(140	)		(149	)
Net accretion of purchase account adjustments		(96	)		(126	)
Other adjustments, principally net changes in other assets and liabilities		(1,205	)		(282	)
Net cash provided by operating activities		1,831			2,053
INVESTING ACTIVITIES
Purchases of investment securities:
Held to maturity		(1,169	)		(7,023	)
Available for sale		-			(12,663	)
Sales of investment securities available for sale		-			6,100
Maturities and calls of investment securities:
Held to maturity		13,984			21,222
Available for sale		3,710			11,528
Disbursement for loan originations net of principal repayments		(3,266	)		(4,358	)
Purchase of loans		-			(26,082	)
Net redemption of FHLB stock		1			510
Purchase of bank premises and equipment		(219	)		(299	)
Net cash provided by (used in) investing activities		13,041			(11,065	)
FINANCING ACTIVITIES
Net decrease in deposits		(4,336	)		(6,747	)
Net decrease in short-term FHLB advances		-			(6,818	)
Repayment of long-term FHLB advances		(31	)		(30	)
Net decrease in mortgage escrow funds		(3,822	)		(3,129	)
Common stock dividends paid		(505	)		-
Issuance of common stock		-			(17	)
Net cash used in financing activities		(8,694	)		(16,741	)
Net increase (decrease) in cash and cash equivalents		6,178			(25,753	)
Cash and cash equivalents:
Cash and cash equivalents at beginning of period		62,145			60,486
Cash and cash equivalents at end of period	$	68,323		$	34,733

See accompanying notes to the consolidated financial statements (unaudited)

6

PCSB Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (unaudited) - (Continued)

(amounts in thousands)

	Three Months Ended September 30,
	2018		2017
Supplemental information:
Cash paid for:
Interest	$	2,122	$	1,379
Income taxes		830		975
Loans transferred to foreclosed real estate and other assets		294		-

See accompanying notes to the consolidated financial statements (unaudited)

7

PCSB Financial Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (unaudited)

Note 1. Basis of Presentation

Nature of Operations: PCSB Financial Corporation (the “Holding Company” and together with its direct and indirect subsidiaries, the “Company”) is a Maryland corporation organized by PCSB Bank (the “Bank”) for the purpose of acquiring all of the capital stock of the Bank issued in the Bank's conversion to stock ownership on April 20, 2017. At September 30, 2018, the significant assets of the Holding Company were the capital stock of the Bank, cash deposited in the Bank, and a loan to the PCSB Bank Employee Stock Ownership Plan (“ESOP”). The liabilities of the Holding Company were insignificant. The Company is subject to the financial reporting requirements of the Securities Exchange Act of 1934, as amended. The Company is subject to regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the New York State Department of Financial Services (the “NYSDFS”).

PCSB Bank is a community-oriented financial institution that provides financial services to individuals and businesses within its market area of Putnam, Southern Dutchess, Rockland and Westchester Counties in New York.  The Bank is a state-chartered stock savings bank and its deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”). The Bank’s primary regulators are the FDIC and the NYSDFS.

Basis of Presentation:  The unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, and include the accounts of the Holding Company, the Bank and the Bank's three subsidiaries – PCSB Funding Corp., PCSB Commercial Bank and UpCounty Realty Corp. (formerly PCSB Realty Ltd.). PCSB Funding Corp. is a real estate investment trust that holds certain mortgage assets.  PCSB Commercial Bank is a state-chartered commercial bank authorized to accept the deposits of local governments in New York State. UpCounty Realty Corp. is a corporation that holds certain properties foreclosed upon by the Bank. All intercompany transactions and balances have been eliminated in consolidation. Financial information for the periods before the Company’s initial public offering (“IPO”) on April 20, 2017 are those of the Bank and its subsidiaries.    

The unaudited consolidated financial statements contained herein reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Such adjustments are the only adjustments reflected in the consolidated financial statements contained herein. The annualized results of operations for the period presented are not necessarily indicative of the results of operations that may be expected for the entire fiscal year. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying unaudited financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended June 30, 2018, included in the Company's annual report on Form 10-K.

Certain prior period amounts have been reclassified to conform to the current presentation. Reclassifications had no effect on prior period net income or equity.

Use of Estimates:  To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.  

Note 2. Recent Accounting Pronouncements

The pronouncements discussed below are not intended to be an all-inclusive list, but rather only those pronouncements that could potentially have a material impact on our financial position, results of operations or disclosures.

Accounting Standards Adopted in the Period

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 “Revenue from Contracts with Customers,” and was later amended by ASU 2015-14, ASU 2016-08, ASU 2016-10, ASU 2016-12 and 2016-20. These updates provide a comprehensive framework for addressing revenue

8

recognition issues that can be applied to all contracts with customers. The amendments also include improved disclosures to enable users of financial statements to better understand the nature, amount, timing and uncertainty of revenue that is recognized.

While the guidance in ASU 2014-09 supersedes most existing industry-specific revenue recognition accounting guidance, much of the Company’s revenue comes from financial instruments such as debt securities and loans that are outside the scope of the guidance. The Company’s material revenue streams that are in the scope of ASU 2014-09 are fees on deposit accounts (including interchange fees) and foreclosed real estate gains and losses. All other revenue streams are immaterial or are in the scope of other GAAP requirements which take precedence and therefore are not in the scope of ASU 2014-09. Based on the Company’s analysis, ASU 2014-09 will not materially change the recognition of revenue on service fees on deposit accounts as the contracts are day to day and recognized as the service is provided. Gains and losses on the sale of foreclosed real estate are generally accounted for under ASC 610. However, ASU 2014-09 also added a new Subtopic 610-20 which addresses the recognition of gains and losses on the transfer of nonfinancial and in-substance nonfinancial assets. Gain and loss recognition is not expected to change except for foreclosed real estate and other nonfinancial asset sales that are financed by the Company. In the case of financed sales, the Company will need to evaluate each contract to determine whether each contract criteria are met, including whether it is probable that it will collect substantially all consideration to which it is entitled. The Company will also need to evaluate whether the financing terms offered to the buyer of the nonfinancial asset are market terms when determining the transaction price.

The Company has evaluated the impact of ASU 2014-09 and the amendments upon adoption as of July 1, 2018. In evaluating this standard, management has determined that the majority of revenue earned by the Company is from revenue streams not included in the scope of this standard and for in scope revenue streams management determined that, based on the modified retrospective method, a cumulative-effect adjustment to opening retained earnings as a result of adopting this standard is not needed. Additional disclosures required under ASU 2014-09 are contained in Note 12.

In January 2016, the FASB issued ASU 2016-01, an amendment to “Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments in ASU 2016-01 are intended to improve the recognition, measurement, presentation and disclosure of financial assets and liabilities to provide users of financial statements with information that is more useful for decision-making purposes. Among other changes, ASU 2016-01 would: (1) require equity securities to be reclassified out of available for sale and measured at fair value with changes in fair value recognized through net income but would allow equity securities that do not have readily determinable fair values to be re-measured at fair value either upon the occurrence of an observable price change or upon identification of an impairment, (2) simplify the impairment assessment of such equity securities and would require enhanced disclosure about these investments, (3) require separate presentation of financial assets and liabilities by measurement category and type of instrument, such as securities or loans, on the balance sheet or in the notes, and would eliminate certain other disclosures relating to the methods and assumptions used to estimate fair value for financial assets measured at amortized cost on the balance sheet, and (4) require the use of an exit price notion when measuring the fair value of financial instruments. The adoption of ASU 2016-01, and subsequent amendments, on July 1, 2018 did not have a material impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU 2017-07 “Compensation – Retirement Benefits”. The ASU requires companies that offer employee defined pension plans, other postretirement benefit plans, or other types of benefit plans accounted for under Topic 715 to report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. The adoption of ASU 2017-07 resulted in non-service cost credits of $83,000 and $47,000 to be included in other operating expense for the three months ended September 30, 2018 and 2017, respectively.

Future Application of Accounting Pronouncements Previously Issued

In February 2016, the FASB issued ASU 2016-02 “Leases.” ASU 2016-02 affects any entity that enters into a lease and is intended to increase the transparency and comparability of financial statements among organizations. The ASU requires, among other changes, a lessee to recognize on its balance sheet a lease asset and a lease liability for those leases previously classified as operating leases. The lease asset would represent the right to use the underlying asset for the lease term and the lease liability would represent the discounted value of the required lease payments to the lessor. The ASU would also require entities to disclose key information about leasing arrangements. The

9

amendments in this update will be effective for the Company for the fiscal year beginning on July 1, 2019, including interim periods within that fiscal year.  Early adoption is permitted. The Company currently leases eleven branches and two administrative offices. ASU 2016-02 will result in the establishment of a right to use asset and corresponding lease obligation, the materiality of which has yet to be determined by management, however the ASU is not expected to have a material impact on the Company’s consolidated results of operations or disclosures.

In June 2016, the FASB issued ASU 2016-13 “Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 affects entities holding financial assets that are not accounted for at fair value through net income, including loans, debt securities, and other financial assets. The ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected by recording an allowance for current expected credit losses. The amendments in this update will be effective for the Company for the fiscal year beginning on July 1, 2020, including interim periods within that fiscal year. Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years. The Company is actively working through the provisions of the Update. Management has established a steering committee which is identifying the methodologies and the additional data requirements necessary to implement the Update and is evaluating the need for a third-party software service provider to assist in the Company's implementation. Management is currently evaluating the impact that ASU 2016-13 will have on the Company’s consolidated financial position, results of operations and disclosures.

In January 2017, the FASB issued ASU 2017-04 “Intangibles – Goodwill and Other (Topic 350).”ASU 2017-04simplifies the test for goodwill impairment, which eliminates the second step in the goodwill impairment test which requires an entity to determine the implied fair value of the reporting unit’s goodwill. Instead, an entity should recognize an impairment loss if the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, with the impairment loss not to exceed the amount of goodwill allocated to the reporting unit. The amendments in this update will be effective for the Company for the fiscal year beginning on July 1, 2019, including interim periods within that fiscal year. Early adoption is permitted for interim or annual goodwill impairment testing performed on testing dates after January 1, 2017. Management expects ASU 2017-04 will not have a significant impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08 "Receivables - Non-Refundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities." The ASU requires premiums on callable debt securities to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. The amendments in this update will be effective for the Company for the fiscal year beginning on July 1, 2020, including interim periods within that fiscal year. Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years. ASU 2017-08 will not have a material impact on the Company’s consolidated financial position, results of operations or disclosures.

Note 3. Shareholders' Equity

The Company completed its initial public offering (“IPO”) on April 20, 2017, in connection with the Bank’s mutual-to-stock conversion, resulting in gross proceeds of $178.3 million, through the sale of 17,826,408 shares, including 1,453,209 shares sold to the PCSB Bank Employee Stock Ownership Plan (ESOP), at the offering price of $10.00 per share. In addition, the Company also contributed 338,702 shares of its common stock and $1.6 million in cash to the PCSB Community Foundation. Expenses related to the offering were $3.7 million, which resulted in net proceeds of $174.6 million prior to the contribution to PCSB Community Foundation. The Company lent $14.5 million to the ESOP and contributed $87.3 million to the Bank, with the remainder of the net proceeds of the offering prior to the contribution to PCSB Community Foundation being retained at the holding company.

Prior to the IPO, the Company had no outstanding shares.

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Note 4. Investment Securities

In association with the adoption of ASU 2016-01, available-for-sale and held-to-maturity debt securities are referred to as investment securities.

The amortized cost, gross unrealized/unrecognized gains and losses and fair value of available for sale and held to maturity securities at September 30, 2018 and June 30, 2018 were as follows:

	September 30, 2018
	Amortized		Gross Unrealized/Unrecognized					Fair
	Cost		Gains		Losses			Value
			(in thousands)
Available for sale:
U.S. Government and agency obligations	$	62,381	$	-	$	(1,024	)	$	61,357
Corporate and other debt securities		8,392		-		(183	)		8,209
Mortgage-backed securities – residential		32,862		88		(976	)		31,974
Total available for sale	$	103,635	$	88	$	(2,183	)	$	101,540
Held to maturity:
U.S. Government and agency obligations	$	117,048	$	-	$	(2,434	)	$	114,614
Corporate and other debt securities		4,000		-		(149	)		3,851
Mortgage-backed securities – residential		136,905		27		(5,577	)		131,355
Mortgage-backed securities – collateralized mortgage obligations		51,052		-		(2,071	)		48,981
Mortgage-backed securities – commercial		31,203		-		(1,042	)		30,161
Total held to maturity	$	340,208	$	27	$	(11,273	)	$	328,962

	June 30, 2018
	Amortized		Gross Unrealized/Unrecognized					Fair
	Cost		Gains		Losses			Value
			(in thousands)
Available for sale:
U.S. Government and agency obligations	$	64,389	$	-	$	(959	)	$	63,430
Corporate and other debt securities		8,406		-		(171	)		8,235
Mortgage-backed securities – residential		34,619		81		(893	)		33,807
Total available for sale	$	107,414	$	81	$	(2,023	)	$	105,472
Held to maturity:
U.S. Government and agency obligations	$	122,048	$	-	$	(2,274	)	$	119,774
Corporate and other debt securities		4,000		-		(126	)		3,874
Mortgage-backed securities – residential		140,478		32		(4,846	)		135,664
Mortgage-backed securities – collateralized mortgage obligations		53,547		-		(1,815	)		51,732
Mortgage-backed securities – commercial		33,110		11		(977	)		32,144
Total held to maturity	$	353,183	$	43	$	(10,038	)	$	343,188

11

No securities were sold during the three months ended September 30, 2018. During the three months ended September 30, 2017, $6.6 million of securities were sold resulting in $173,000 of net realized gains. Included was the disposal of $681,000 of securities classified as held to maturity, resulting in net realized gains of $34,000. These securities were comprised of seasoned mortgage-backed securities where the Company collected a substantial portion (at least 85%) of the principal outstanding at acquisition due to prepayments or scheduled payments payable in equal installments, comprising both principal and interest, over the terms.

The following table presents the fair value and carrying amount of debt securities at September 30, 2018, by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.

	Held to maturity				Available for sale
	Carrying		Fair		Amortized		Fair
	Amount		Value		Cost		Value
	(in thousands)
September 30, 2018:
1 year or less	$	26,503	$	26,327	$	16,399	$	16,298
1 to 5 years		90,545		88,287		52,374		51,290
5 to 10 years		-		-		2,000		1,978
Mortgage-backed securities and other		223,160		214,348		32,862		31,974
Total	$	340,208	$	328,962	$	103,635	$	101,540

Securities pledged had carrying amounts of $136.4 million and $140.5 million at September 30, 2018 and June 30, 2018, respectively, and were pledged principally to secure FHLB advances and public deposits.

The following table provides information regarding investment securities with unrealized/unrecognized losses, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position at September 30, 2018 and June 30, 2018:

	September 30, 2018
	Less than 12 months					12 months or greater					Total
			Unrealized/					Unrealized/					Unrealized/
	Fair		Unrecognized			Fair		Unrecognized			Fair		Unrecognized
	Value		Loss			Value		Loss			Value		Loss
	(in thousands)
Available for sale:
U.S. Government and agency obligations	$	19,649	$	(249	)	$	41,708	$	(775	)	$	61,357	$	(1,024	)
Corporate and other debt securities		5,258		(126	)		2,951		(57	)		8,209		(183	)
Mortgage-backed securities – residential		1,395		(36	)		25,582		(940	)		26,977		(976	)
Total available for sale	$	26,302	$	(411	)	$	70,241	$	(1,772	)	$	96,543	$	(2,183	)
Held to maturity:
U.S. Government and agency obligations	$	23,027	$	(463	)	$	91,586	$	(1,971	)		114,613	$	(2,434	)
Corporate and other debt securities		3,851		(149	)		-		-			3,851		(149	)
Mortgage-backed securities – residential		79,296		(3,018	)		51,392		(2,559	)		130,688		(5,577	)
Mortgage-backed securities – collateralized    mortgage obligations		16,699		(515	)		32,282		(1,556	)		48,981		(2,071	)
Mortgage-backed securities – commercial		16,934		(496	)		11,492		(546	)		28,426		(1,042	)
Total held to maturity	$	139,807	$	(4,641	)	$	186,752	$	(6,632	)	$	326,559	$	(11,273	)

12

	June 30, 2018
	Less than 12 months					12 months or greater					Total
			Unrealized/					Unrealized/					Unrealized/
	Fair		Unrecognized			Fair		Unrecognized			Fair		Unrecognized
	Value		Loss			Value		Loss			Value		Loss
	(in thousands)
Available for sale
U.S. Government and agency obligations	$	41,762	$	(569	)	$	21,668	$	(390	)	$	63,430	$	(959	)
Corporate and other debt securities		6,258		(148	)		1,977.00		(23.00	)		8,235		(171	)
Mortgage-backed securities – residential		13,397		(379	)		14,718		(514	)		28,115		(893	)
Total available for sale	$	61,417	$	(1,096	)	$	38,363	$	(927	)	$	99,780	$	(2,023	)
Held to maturity
U.S. Government and agency obligations	$	46,163	$	(871	)	$	71,611	$	(1,403	)	$	117,774	$	(2,274	)
Corporate and other debt securities		3,874		(126	)		-		-			3,874		(126	)
Mortgage-backed securities – residential		102,496		(3,338	)		32,490		(1,508	)		134,986		(4,846	)
Mortgage-backed securities – collateralized    mortgage obligations		31,124		(884	)		20,608		(931	)		51,732		(1,815	)
Mortgage-backed securities – commercial		21,762		(582	)		8,629		(395.00	)		30,391		(977	)
Total held to maturity	$	205,419	$	(5,801	)	$	133,338	$	(4,237	)	$	338,757	$	(10,038	)

As of September 30, 2018, the Company’s security portfolio consisted of $441.7 million in securities, of which 250 securities with a fair value of $423.1 million were in an unrealized loss position.

As of June 30, 2018, the Company’s security portfolio consisted of $458.7 million in securities, of which 254 securities with a fair value of $438.5 million were in an unrealized loss position.

There were no securities for which the Company believes it is not probable that it will collect all amounts due according to the contractual terms of the security as of September 30, 2018 and June 30, 2018. Management believes the unrealized losses are primarily a result of changes in interest rates. The Company has determined that it does not intend to sell, or it is not more likely than not that it will be required to sell, its securities that are in an unrealized loss position prior to the recovery of its amortized cost basis. Therefore, the Company did not consider any securities to be other-than-temporarily impaired as of September 30, 2018 or June 30, 2018.

13

Note 5. Loans Receivable

Loans receivable are summarized as follows (in thousands):

	September 30,			June 30,
	2018			2018
Mortgage loans:
Residential	$	249,894		$	250,578
Commercial		495,944			495,265
Construction		16,890			17,352
Net deferred loan origination costs		859			1,041
Total mortgage loans		763,587			764,236
Commercial and consumer loans:
Commercial loans		110,196			104,135
Home equity lines of credit		35,191			37,395
Consumer and overdrafts		344			745
Net deferred loan origination costs		734			729
Total commercial and consumer loans		146,465			143,004
Total loans receivable		910,052			907,240
Allowance for loan losses		(4,959	)		(4,904	)
Loans receivable, net	$	905,093		$	902,336

In 2015, the Company completed a merger with CMS Bancorp and its wholly owned subsidiary, CMS Bank. References to acquired loans in this note pertain only to those loans acquired as part of the merger.

14

The following tables present the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2018 and 2017 (in thousands):

	Three Months Ended September 30, 2018
	Beginning Allowance		Provision (credit)			Charge-offs			Recoveries		Ending Allowance
Originated:
Residential	$	386	$	(29	)	$	-		$	2	$	359
Commercial		3,073		57			-			-		3,130
Construction		505		(12	)		-			-		493
Commercial loans		780		45			-			-		825
Home equity lines of credit		80		(11	)		-			-		69
Consumer and overdrafts		7		8			(7	)		2		10
Acquired:
Residential		73		-			-			-		73
Total	$	4,904	$	58		$	(7	)	$	4	$	4,959
	Three Months Ended September 30, 2017
	Beginning Allowance		Provision (credit)			Charge-offs			Recoveries		Ending Allowance
Originated:
Residential	$	360	$	64		$	(17	)	$	-	$	407
Commercial		2,589		120			-			-		2,709
Construction		1,150		10			-			-		1,160
Commercial loans		949		(60	)		-			-		889
Home equity lines of credit		76		1			-			-		77
Consumer and overdrafts		-		-			-			-		-
Acquired:
Residential		26		-			-			-		26
Total	$	5,150	$	135		$	(17	)	$	-	$	5,268

15

The following tables present the balance in the allowance for loan losses and the recorded investment in loans, excluding net deferred fees and accrued interest, by portfolio segment, and based on impairment method as of September 30, 2018 and June 30, 2018 (in thousands):

	September 30, 2018
	Loans								Allowance for Loan Losses
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total
Residential	$	2,224	$	246,375	$	1,295	$	249,894	$	123	$	236	$	73	$	432
Commercial		1,425		493,044		1,475		495,944		-		3,130		-		3,130
Construction		2,260		14,630		-		16,890		276		217		-		493
Commercial loans		2,432		107,764		-		110,196		3		822		-		825
Home equity lines of credit		312		34,714		165		35,191		4		65		-		69
Consumer and overdrafts		-		344		-		344		-		10		-		10
Total	$	8,653	$	896,871	$	2,935	$	908,459	$	406	$	4,480	$	73	$	4,959

	June 30, 2018
	Loans								Allowance for Loan Losses
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Acquired With Deteriorated Credit Quality		Total
Residential	$	2,360	$	246,913	$	1,305	$	250,578	$	154	$	232	$	73	$	459
Commercial		1,683		492,105		1,477		495,265		-		3,073		-		3,073
Construction		2,260		15,092		-		17,352		276		229		-		505
Commercial loans		2,451		101,684		-		104,135		9		771		-		780
Home equity lines of credit		360		36,867		168		37,395		12		68		-		80
Consumer and overdrafts		-		745		-		745		-		7		-		7
Total	$	9,114	$	893,406	$	2,950	$	905,470	$	451	$	4,380	$	73	$	4,904

16

The following tables present information related to loans individually evaluated for impairment (excluding loans acquired with deteriorated credit quality) by class of loans as of September 30, 2018 and June 30, 2018 (in thousands):

	September 30, 2018
	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses
With no related allowance recorded:
Residential	$	1,829	$	1,775	$	-
Commercial		1,500		1,425		-
Commercial loans		2,531		2,369		-
Home equity lines of credit		369		301		-
With a related allowance recorded:
Residential		386		449		123
Construction		3,257		2,260		276
Commercial loans		63		63		3
Home equity lines of credit		11		11		4
Total	$	9,946	$	8,653	$	406

	June 30, 2018
	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses
With no related allowance recorded:
Residential	$	1,659	$	1,576	$	-
Commercial		1,765		1,683		-
Commercial loans		2,254		2,098		-
Home equity lines of credit		341		341		-
With a related allowance recorded:
Residential		742		784		154
Construction		3,257		2,260		276
Commercial loans		353		353		9
Home equity lines of credit		84		19		12
Total	$	10,455	$	9,114	$	451

17

The table below presents the average recorded investment and interest income recognized on loans individually evaluated for impairment, by class of loans, for the three and nine months ended September 30, 2018 and 2017 (in thousands):

	Three months ended				Three months ended
	September 30, 2018				September 30, 2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Residential	$	1,845	$	28	$	3,894	$	42
Commercial		1,621		39		2,445		27
Construction		-		-		303		17
Commercial loans		2,377		143		4,680		83
Home equity lines of credit		326		6		635		-
With a related allowance recorded:
Residential		450		11		620		4
Construction		2,260		-		3,257		-
Commercial loans		64		2		1,459		18
Home equity lines of credit		11		-		11		-
Total	$	8,954	$	229	$	17,304	$	191

The following table presents the recorded investment in nonaccrual loans and in loans past due over 90 days and still on accrual status, by class of loans as of September 30, 2018 and June 30, 2018 (in thousands):

					Loans Past Due Over 90 Days
	Nonaccrual				and Still Accruing
	September 30,		June 30,		September 30,		June 30,
	2018		2018		2018		2018
Originated:
Residential	$	488	$	604	$	-	$	-
Commercial		-		262		-		-
Construction		2,260		2,260		-		-
Commercial loans		783		788		-		-
Home equity lines of credit		78		45		-		-
Consumer and overdrafts		1		-		10
Acquired:
Residential		1,288		1,308		-		-
Commercial		543		532		-		-
Home equity lines of credit		300		303		-		-
Total	$	5,741	$	6,102	$	10	$	-

Nonperforming loans include both smaller-balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. The table above excludes acquired loans past due over 90 days that are accounted for as purchased credit impaired loans totaling $1.1 million as of both September 30, 2018 and June 30, 2018. Such loans are excluded because the loans are in pools that are considered performing. The discounts arising from recording these loans at fair value upon acquisition were due in part to credit quality and the accretable yield is being recognized as interest income over the life of the loans based on expected cash flows.

18

The following tables present the aging of the recorded investment in past due loans by class of loans as of September 30, 2018 and June 30, 2018 (in thousands):

	September 30, 2018
	30-59		60-89		90 Days or
	Days Past		Days Past		More Past		Total Past
	Due		Due		Due		Due		Current		Total
Originated:
Residential	$	66	$	-	$	488	$	554	$	196,034	$	196,588
Commercial		-		-		-		-		424,071		424,071
Construction		-		-		2,260		2,260		14,630		16,890
Commercial loans		158		-		500		658		109,289		109,947
Home equity lines of credit		-		-		-		-		30,748		30,748
Consumer and overdrafts		-		1		11		12		332		344
Total originated		224		1		3,259		3,484		775,104		778,588
Acquired:
Residential		-		-		1,485		1,485		51,821		53,306
Commercial		-		-		1,122		1,122		70,751		71,873
Commercial loans		-		-		-		-		249		249
Home equity lines of credit		-		-		319		319		4,124		4,443
Total acquired		-		-		2,926		2,926		126,945		129,871
Total	$	224	$	1	$	6,185	$	6,410	$	902,049	$	908,459

	June 30, 2018
	30-59		60-89		90 Days or
	Days Past		Days Past		More Past		Total Past
	Due		Due		Due		Due		Current		Total
Originated:
Residential	$	-	$	394	$	210	$	604	$	194,986	$	195,590
Commercial		-		-		262		262		420,320		420,582
Construction		-		-		2,260		2,260		15,092		17,352
Commercial loans		-		-		500		500		102,767		103,267
Home equity lines of credit		-		-		45		45		32,311		32,356
Consumer and overdrafts		-		-		-		-		733		733
Total originated		-		394		3,277		3,671		766,209		769,880
Acquired:
Residential		-		232		1,806		2,038		52,950		54,988
Commercial		-		-		1,112		1,112		73,571		74,683
Commercial loans		-		-		-		-		868		868
Home equity lines of credit		30		-		296		326		4,713		5,039
Consumer and overdrafts		-		-		-		-		12		12
Total acquired		30		232		3,214		3,476		132,114		135,590
Total	$	30	$	626	$	6,491	$	7,147	$	898,323	$	905,470

Troubled Debt Restructurings

The terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

As of September 30, 2018 and June 30, 2018, the Company had 13 and 12 loans classified as troubled debt restructurings totaling $4.1 million and $3.8 million, respectively. The Company has allocated $131,000 and $139,000, respectively, of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2018 and June 30, 2018 and has not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings.

19

The Company modified two loans with a total carrying amount of $428,000, one residential mortgage and one home equity line of credit, in troubled debt restructurings during the three months ended September 30, 2018. The Company did not modify any loans as troubled debt restructuring during the three months ended September 30, 2017.

The Company had no troubled debt restructurings for which there was a payment default in the three months ended September 30, 2018 that were modified in the twelve months prior to default. There was one troubled debt restructuring with a total carrying amount of $2.4 million for which there was a payment default in the three months ended September 30, 2017 and resulted in no increase to the allowance for loan losses.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a monthly basis. The Company utilized the same grading process for acquired loans as it does for originated loans. The Company uses the following definitions for risk ratings:

Special Mention – Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

20

Loans not meeting the criteria above that are analyzed individually as part of the above-described process and loans in groups of homogenous loans are considered to be pass rated loans. These loans are monitored based on delinquency and performance. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):

	September 30, 2018
	Pass		Special Mention		Substandard		Doubtful		Total
Originated:
Residential	$	195,207	$	736	$	645	$	-	$	196,588
Commercial		423,921		-		150		-		424,071
Construction		14,630		-		2,260		-		16,890
Commercial loans		105,137		158		4,652		-		109,947
Home equity lines of credit		30,503		167		78		-		30,748
Consumer and overdrafts		344		-		-		-		344
Total originated		769,742		1,061		7,785		-		778,588
Acquired:
Residential		50,210		247		2,849		-		53,306
Commercial		69,019		836		2,018		-		71,873
Commercial loans		241		8		-		-		249
Home equity lines of credit		4,048		-		395		-		4,443
Total acquired		123,518		1,091		5,262		-		129,871
Total	$	893,260	$	2,152	$	13,047	$	-	$	908,459

	June 30, 2018
	Pass		Special Mention		Substandard		Doubtful		Total
Originated:
Residential	$	194,341	$	571	$	678	$	-	$	195,590
Commercial		418,370		-		2,212		-		420,582
Construction		15,092		-		2,260		-		17,352
Commercial loans		98,205		167		4,895		-		103,267
Home equity lines of credit		32,167		144		45		-		32,356
Consumer and overdrafts		733		-				-		733
Total originated		758,908		882		10,090		-		769,880
Acquired:
Residential		51,858		249		2,881		-		54,988
Commercial		71,832		842		2,009		-		74,683
Commercial loans		857		11		-		-		868
Home equity lines of credit		4,641		-		398		-		5,039
Consumer and overdrafts		12		-		-		-		12
Total acquired		129,200		1,102		5,288		-		135,590
Total	$	888,108	$	1,984	$	15,378	$	-	$	905,470

21

Purchased Credit Impaired Loans

The Company has acquired loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans as of September 30, 2018 and June 30, 2018 is as follows (in thousands):

	September 30,		June 30,
	2018		2018
Residential	$	1,222	$	1,232
Commercial		1,475		1,477
Home equity lines of credit		-		-
Consumer and installment loans		165		168
Carrying amount, net of allowance of $73 and $73, respectively	$	2,862	$	2,877

The allowance for loan losses on purchased credit impaired loans was unchanged during the three months ended September 30, 2018 and 2017.

Accretable yield, or income expected to be collected, for acquired loans is as follows (in thousands):

	Three Months Ended September 30,
	2018			2017
Beginning balance	$	245		$	403
New loans acquired		-			-
Accretion income		(13	)		(28	)
Reclassification from non-accretable difference		-			-
Disposals		-			-
Ending balance	$	232		$	375

Note 6. Other Comprehensive Income (Loss)

The following is a summary of the accumulated other comprehensive income (loss) balances, net of tax (in thousands):

	Net unrealized gain (loss) on available for sale securities			Unrealized loss on pension benefits			Unrealized loss on SERP benefits			Total
Balance at July 1, 2018	$	(1,536	)	$	(5,150	)	$	(264	)	$	(6,950	)
Other comprehensive income before reclassifications		(153	)		-			-			(153	)
Amounts reclassified from accumulated other comprehensive income		-			145			9			154
Less tax effect		32			(30	)		(2	)		-
Net other comprehensive income		(121	)		115			7			1
Balance at September 30, 2018	$	(1,657	)	$	(5,035	)	$	(257	)	$	(6,949	)
	Net unrealized gain (loss) on available for sale securities			Unrealized loss on pension benefits			Unrealized loss on SERP benefits			Total
Balance at July 1, 2017	$	37		$	(5,002	)	$	(250	)	$	(5,215	)
Other comprehensive income before reclassifications		(213	)		-			-			(213	)
Amounts reclassified from accumulated other comprehensive income		(139	)		181			8			50
Less tax effect		120			(62	)		(2	)		56
Net other comprehensive income		(232	)		119			6			(107	)
Balance at September 30, 2017	$	(195	)	$	(4,883	)	$	(244	)	$	(5,322	)

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Note 7. Post-Retirement Benefits

Employee Pension Plan: The Company maintains a non-contributory defined benefit pension plan that covers employees meeting specific requirements as to age and length of service. The Company’s contributions to this qualified plan are determined on the basis of (i) the maximum amount that can be deducted for federal income tax purposes, and (ii) the amount determined by a consulting actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974 (“ERISA”). Contributions are intended to provide for benefits attributed to service to date.On February 15, 2017, the Board of Directors approved the freezing of the defined benefit pension plan effective May 1, 2017.

Supplemental Retirement Plans: The Company also maintains unfunded and non-qualified supplemental retirement plans ("SERP") to provide pension benefits in addition to those provided under the qualified pension plan.

Net periodic benefit cost and other amounts recognized in other comprehensive income for the three months ended September 30, 2018 and 2017 (in thousands):

	Three Months Ended					Three Months Ended
	September 30, 2018					September 30, 2017
	Defined Benefit Plan			Supplemental Retirement Plans		Defined Benefit Plan			Supplemental Retirement Plans
Service cost	$	-		$	148	$	-		$	113
Interest cost		250			26		242			25
Expected return on plan assets		(513	)		-		(503	)		-
Amortization of prior net loss		145			9		-			-
Amortization of prior service cost		-			-		181			8
Net periodic (benefit) cost	$	(118	)	$	183	$	(80	)	$	146

The Company made no contributions to the defined benefit plan during the three months ended September 30, 2018 and expects to make no contributions to the plan for the year ending June 30, 2019.

Employee Stock Ownership Plan

On January 1, 2017, the Company established an Employee Stock Ownership Plan (“ESOP”) to provide eligible employees the opportunity to own Company stock. The plan is a tax-qualified retirement plan for the benefit of Company employees. On April 20, 2017 Company granted a loan to the ESOP for the purchase of 1,453,209 shares of the Company’s common stock at a price of $10.00 per share. The loan obtained by the ESOP from the Company to purchase the common stock is payable annually over 15 years at a rate per annum equal to the Prime Rate, reset annually on January 1st (4.5% at September 30, 2018). Loan payments are principally funded by cash contributions from the Bank. The loan is secured by the shares purchased, which are held in a suspense account for allocation among participants as the loan is repaid. The balance of the ESOP loan at September 30, 2018 was $13.6 million. Contributions are allocated to eligible participants on the basis of compensation, subject to federal tax limits. The number of shares committed to be released annually is 96,881 through 2032.

Shares held by the ESOP include the following (dollars in thousands):

	September 30, 2018		June 30, 2018
Allocated to participants		169,342		144,923
Unearned		1,283,867		1,308,286
Total ESOP shares		1,453,209		1,453,209
Fair value of unearned shares	$	26,114	$	25,996

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Total compensation expense recognized in connection with the ESOP for the three months ended September 30, 2018 and 2017 was $493,000 and $607,000, respectively.

Note 8. Fair Value of Financial Instruments

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as general classification of such instruments pursuant to the valuation hierarchy, is set forth below. While management believes the Company’s valuation methodologies are appropriate and consistent with other financial institutions, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  

Investment Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs), or a broker's opinion of value (Level 3 inputs).  

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. Appraisals are generally obtained annually and may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Management performs a review of all appraisals, including any such adjustments.

Foreclosed Real Estate: Assets acquired through or instead of loan foreclosure are initially recorded at fair value, less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value, less estimated costs to sell.  Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for both collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Credit Department, as well as a third-party specialist, where deemed appropriate, reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Once appraisals are considered appropriate, management discounts the appraised value for estimated selling costs, such as legal, broker, and property maintenance and insurance costs.  The most recent analysis performed indicated discount rates ranging between 10% and 20% should be applied to properties with appraisals performed.

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Assets and liabilities measured at fair value are summarized below (in thousands):

	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
September 30, 2018
Measured on a recurring basis:
Available for sale securities:
U.S. Government and agency obligations	$	-	$	61,357	$	-	$	61,357
Corporate and other debt securities		-		8,209		-		8,209
Mortgage-backed securities – residential		-		31,974		-		31,974
Derivatives – interest rate contracts		-		105		-		105
Total assets at fair value	$	-	$	101,645	$	-	$	101,645
Derivatives – interest rate contracts	$	-	$	105	$	-	$	105
Total liabilities at fair value	$	-	$	105	$	-	$	105
Measured on a non-recurring basis:
Impaired loans:
Residential mortgages	$	-	$	-	$	322	$	322
Construction		-		-		1,984		1,984
Commercial loans		-		-		561		561
Home equity lines of credit		-		-		7		7
Foreclosed real estate		23		-		731		754
Total assets at fair value	$	23	$	-	$	3,605	$	3,628

	Fair Value Measurements
	Level 1		Level 2		Level 3		Total
June 30, 2018
Measured on a recurring basis:
Available for sale securities:
U.S. Government and agency obligations	$	-	$	63,430	$	-	$	63,430
Corporate and other debt securities		-		8,235		-		8,235
Mortgage-backed securities – residential		-		33,807		-		33,807
Total assets at fair value	$	-	$	105,472	$	-	$	105,472
Measured on a non-recurring basis:
Impaired loans:
Residential mortgages	$	-	$	-	$	688	$	688
Construction		-		-		1,984		1,984
Commercial loans		-		-		845		845
Home equity lines of credit		-		-		7		7
Foreclosed real estate		-		-		460		460
Total assets at fair value	$	-	$	-	$	3,984	$	3,984

There were no transfers between levels within the fair value hierarchy during the three months ended September 30, 2018 or 2017.

Impaired loans in the preceding table had a carrying amount of $3.3 million, and a remaining valuation allowance of $412,000 at September 30, 2018, as compared to $3.9 million and $451,000, respectively, as of June 30, 2018. Impaired loans measured at fair value incurred no net charge-offs and resulted in an additional credit for loan losses of $5,000 during the three months ended September 30, 2018. Impaired loans measured at fair value as of September 30, 2017 incurred $17,000 of net charge-offs and resulted in an additional provision for loan losses of $48,000 during the three months ended September 30, 2017.

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The following tables present quantitative information about Level 3 fair value measurements for selected financial instruments measured at fair value on a non-recurring basis at September 30, 2018 and June 30, 2018 (dollars in thousands):

			Valuation	Unobservable	Range or
	Fair Value		Technique(s)	Input(s)	Rate Used
September 30, 2018:
Impaired loans - residential mortgages	$	322	Discounted cash flow	Discount rate	5.4% to 6.3%
Impaired loans - construction		1,984	Sales contract	Discount to sales contract	9.8%
Impaired loans - commercial loans		561	Discounted cash flow	Discount rate	7.0% to 7.5%
			Sales contract	Discount to sales contract	9.8%
Impaired loans - home equity lines of credit		7	Discounted cash flow	Discount rate	6.3%
Foreclosed real estate		731	Sales comparison	Adjustments for differences in sales comparables	-45.0% to -0.4%
June 30, 2018:
Impaired loans - residential mortgages	$	688	Sales comparison	Adjustments for differences in sales comparables	-5.1% to 20.9%
			Discounted cash flow	Discount rate	5.4% to 6.3%
Impaired loans - construction		1,984	Sales contract	Discount to sales contract	9.8%
Impaired loans - commercial loans		845	Discounted cash flow	Discount rate	5.3% to 7.5%
			Sales contract	Discount to sales contract	9.8%
Impaired loans - home equity lines of credit		7	Sales comparison	Adjustments for differences in sales comparables	-5.1% to 20.9%
			Discounted cash flow	Discount rate	6.3%
Foreclosed real estate		460	Sales comparison	Adjustments for differences in sales comparables	-8.1% to -0.4%

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The following is a summary of the carrying amounts and estimated fair values of the Company’s financial assets and liabilities (in thousands) (none of which are held for trading purposes):

	Carrying		Fair Value Measurements
	Amount		Level 1		Level 2		Level 3		Total
September 30, 2018:
Financial assets:
Cash and cash equivalents	$	68,323	$	68,323	$	-	$	-	$	68,323
Investment securities held to maturity		340,208		-		328,962		-		328,962
Investment securities available for sale		101,540		-		101,540		-		101,540
Loans receivable, net		905,093		-		-		885,274		885,274
Accrued interest receivable		4,747		-		1,562		3,104		4,666
Federal Home Loan Bank stock		2,049	N/A		N/A		N/A		N/A
Derivative assets - interest rate contracts		105		-		105		-		105
Financial liabilities:
Demand, NOW, money market deposits and savings accounts		756,928		756,928		-		-		756,928
Time deposits		396,193		-		398,420		-		398,420
Mortgage escrow funds		4,981		4,981		-		-		4,981
FHLB advances		18,810		-		20,190		-		20,190
Derivative liabilities - interest rate contracts		105		-		105		-		105
June 30, 2018:
Financial assets:
Cash and cash equivalents	$	62,145	$	62,145	$	-	$	-	$	62,145
Investment securities held to maturity		353,183		-		343,188		-		343,188
Investment securities available for sale		105,472		-		105,472		-		105,472
Loans receivable, net		902,336		-		-		882,319		882,319
Accrued interest receivable		4,358		-		1,402		2,956		4,358
Federal Home Loan Bank stock		2,050	N/A		N/A		N/A		N/A
Financial liabilities:
Demand, NOW, money market deposits and savings accounts		765,084		765,084		-		-		765,084
Time deposits		392,373		-		394,205		-		394,205
Mortgage escrow funds		8,803		8,803		-		-		8,803
FHLB advances		18,841		-		20,574		-		20,574

In connection with the adoption of ASU 2016-01 on July 1, 2018, we refined our methodology to estimate the fair value of our loan portfolio using an exit price notion resulting in prior periods no longer being comparable. The exit price notion requires determination of the price at which willing market participants would transact at the measurement date under current market conditions depending on facts and circumstances, such as origination rates, credit risk, transaction costs, liquidity, national and regional market trends and other adjustments, utilizing publicly available rates and indices. The application of an exit price notion requires the use of significant judgment. The prior period estimate of loans receivable, net was determined using an entrance price methodology based only on the discounted value of contracted cash flows based on prevailing interest rates.

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Note 9. Regulatory Capital

The following is a summary of the Company’s and Bank’s actual capital amounts and ratios as of September 30, 2018 and June 30, 2018, compared to the required ratios for minimum capital adequacy and for classification as well capitalized (dollars in thousands): 

											To Be Well Capitalized
											Under Prompt
						For Capital Adequacy					Corrective Action
	Bank Actual					Purposes					Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2018:
PCSB Bank
Leverage (Tier 1)	$	203,094		13.8	%	$	58,870		4.0	%	$	73,587		5.0	%
Risk-based:
Common Tier 1		203,094		21.2			43,178		4.5			62,369		6.5
Tier 1		203,094		21.2			57,571		6.0			76,762		8.0
Total		208,053		21.7			76,762		8.0			95,952		10.0
PCSB Financial Corporation
Leverage (Tier 1)	$	290,287		19.7	%	$	58,991		4.0	%	N/A		N/A
Risk-based:
Common Tier 1		290,287		30.2			43,219		4.5		N/A		N/A
Tier 1		290,287		30.2			57,625		6.0		N/A		N/A
Total		295,246		30.7			76,834		8.0		N/A		N/A
June 30, 2018:
PCSB Bank
Leverage (Tier 1)	$	200,488		13.6	%	$	58,924		4.0	%	$	73,655		5.0	%
Risk-based:
Common Tier 1		200,488		21.1			42,745		4.5			61,743		6.5
Tier 1		200,488		21.1			56,994		6.0			75,991		8.0
Total		205,392		21.6			75,991		8.0			94,989		10.0
PCSB Financial Corporation
Leverage (Tier 1)	$	287,991		19.5	%	$	58,948		4.0	%	N/A		N/A
Risk-based:
Common Tier 1		287,991		30.3			42,783		4.5		N/A		N/A
Tier 1		287,991		30.3			57,044		6.0		N/A		N/A
Total		292,895		30.8			76,058		8.0		N/A		N/A

In addition to the ratios above, the Basel III Capital Rules have established that community banking institutions must maintain a capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

Management believes that as of September 30, 2018 and June 30, 2018, the Bank and Company met all capital adequacy requirements to which they were subject, including the capital conservation buffer of 1.875% as of September 30, 2018 and June 30, 2018, respectively. Further, the most recent FDIC notification categorized the Bank as a well-capitalized institution under the prompt corrective action regulations. There have been no conditions or events since that notification that management believes have changed the Bank’s capital classification.

Note 10. Earnings Per Share

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Unallocated ESOP shares are not deemed outstanding for

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earnings per share calculations. There were no potentially dilutive common stock equivalents during the three months ended September 30, 2018 and 2017, respectively.

	Three Months Ended September 30,
	2018		2017
	(dollars in thousands, except share and per share data)
Net income applicable to common stock	$	2,329	$	1,756
Average number of common shares outstanding		18,165,110		18,165,110
Less: Average unallocated ESOP shares		1,296,010		1,408,663
Average number of common shares outstanding used to calculate basic earnings per common share		16,869,100		16,756,447
Earnings per Common share:
Basic	$	0.14	$	0.10
Diluted	$	0.14	$	0.10

Note 11. Derivatives and Hedging

Derivatives not designated as hedges may be used to manage the Company’s exposure to interest rate movements or to provide service to customers. The Company executes interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that the Company executes with a third party in order to minimize the net risk exposure resulting from such transactions. These interest rate swap agreements do not qualify for hedge accounting treatment, and therefore changes in fair value are reported in current period earnings.

The Company had no interest rate swaps at June 30, 2018. The following table presents summary information about the interest rate swaps as of September 30, 2018:

	September 30,
(dollars in thousands)	2018
Notional amounts	$	12,000
Weighted average pay rates		4.32	%
Weighted average receive rates		4.32	%
Weighted average maturity	10.00 years
Fair value of combined interest rate swaps		-

Note 12. Revenue From Contracts With Customers

The Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), on July 1, 2018. Under ASC 2014-09, an entity is required to recognize revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  ASU 2014-09 also requires disclosure of sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, as well as qualitative and quantitative disclosure related to contracts with certain customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract.

In accordance with ASU 2014-09, revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these services. The Company applies the following five steps to properly recognize revenue:

1. Identify the contract with a customer

2. Identify the performance obligations in the contract

3. Determine the transaction price

4. Allocate the transaction price to performance obligations in the contract

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5. Recognize revenue when (or as) the Company satisfies a performance obligation

The Company’s in-scope revenue streams that are subject to the accounting standard are: (1) fees and service charges on deposit accounts (including interchange fees), which, are included on the Consolidated Statements of Operations as “Fees and service charges” and (2) gains on the sale of foreclosed real estate. For the three months ended September 30, 2018 and 2017, fees and services charges totaled $418,000 and $381,000, respectively, of which $392,000 and $291,000, respectively, are in-scope revenue streams.

Fees and Service Charges on Deposit Accounts. The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payments, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of the month, representing the period over which the Company satisfied the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance. Fees and service charges on deposit accounts were $287,000 and $196,000, respectively, for the three months ended September 30, 2018 and 2017.

Interchange Income. The Company earns interchange fees from debit cardholder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Interchange income was $105,000 and $95,000, respectively, for the three months ended September 30, 2018 and 2017.

Gain/Losses on Sales of Foreclosed Real Estate. The Company records a gain or loss from the sale of foreclosed real estate when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of foreclosed real estate to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the foreclosed real estate asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. The Company recorded no gains on sale of foreclosed real estate for the three months ended September 30, 2018 or 2017.

Note 13. Subsequent Events

On October 24, 2018, the Company’s shareholders approved the PCSB Financial Corporation 2018 Equity Incentive Plan (the “Plan”), which permits the grant of stock options and time-based restricted stock and/or restricted stock units. The total number of shares that may be granted under the Plan is 2,543,115, of which 1,816,511 shares may be granted as stock options and 726,604 shares may be granted as restricted stock and restricted stock units. Concurrent with the approval of the Plan, on October 24, 2018, 413,039 stock options and 183,884 restricted stock awards were granted to non-employee directors.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

General

Management’s discussion and analysis of financial condition at September 30, 2018 and June 30, 2018, and results of operations for the three months ended September 30, 2018 and 2017 is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the unaudited financial statements and the notes thereto appearing in Part I, Item 1, of this quarterly report on Form 10-Q and with the audited financial statements included in the annual report on Form 10-K for the fiscal year ended June 30, 2018.

Cautionary Note Regarding Forward-Looking Statements

This quarterly report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning.  These forward-looking statements include, but are not limited to:

• statements of our goals, intentions and expectations;

• statements regarding our business plans, prospects, growth and operating strategies;

• statements regarding the quality of our loan and investment portfolios; and

• estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

• general economic conditions, either nationally or in our market areas, that are worse than expected;

• changes in the level and direction of loan delinquencies and charge-offs and changes in estimates of the adequacy of the allowance for loan losses;

• our ability to access cost-effective funding;

• fluctuations in real estate values and both residential and commercial real estate market conditions;

• demand for loans and deposits in our market area;

• our ability to continue to implement our business strategies;

• competition among depository and other financial institutions;

• inflation and changes in the interest rate environment that reduce our margins and yields, reduce the fair value of financial instruments or reduce the origination levels in our lending business, or increase the level of defaults, losses and prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;

• adverse changes in the securities or credit markets;

• changes in laws or government regulations or policies affecting financial institutions, including changes in tax laws, regulatory fees, and capital requirements, including as a result of Basel III;

• our ability to manage market risk, credit risk and operational risk in the current economic conditions;

• our ability to enter new markets successfully and capitalize on growth opportunities;

• our ability to successfully integrate any assets, liabilities, customers, systems and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

• changes in consumer spending, borrowing and savings habits;

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• changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board;

• our ability to retain key employees;

• our compensation expense associated with equity allocated or awarded to our employees; and

• changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

Additional factors that may affect our results are discussed in the annual report on Form 10-K for the fiscal year ended June 30, 2018, under the heading “Risk Factors.”

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. The company assumes no obligation to update any forward looking statements except as may be required by applicable law or regulation.

Critical Accounting Policies

Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Management believes that the most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:

Allowance for Loan Losses. The allowance for loan losses is established as probable incurred losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

Comparison of Financial Condition at September 30, 2018 and June 30, 2018

Total Assets. Total assets decreased $5.7 million, or 0.4%, to $1.47 billion at September 30, 2018 from $1.48 billion at June 30, 2018. The decrease is primarily the result of a decrease of $16.9 million in total investment securities, partially offset by increases of $6.2 million in cash and cash equivalents, $2.8 million in net loans receivable and $2.2 million in all other assets.

Cash and Cash Equivalents. Cash and cash equivalents increased $6.2 million, or 9.9%, to $68.3 million at September 30, 2018 from $62.1 million at June 30, 2018. The increase was primarily attributable to a $16.9 million decrease in total investment securities, partially offset by a $4.3 million decrease in deposits, a $3.8 million decrease in mortgage escrow funds, and $2.8 million increase in net loans receivable.

Securities Held-to-Maturity. Total securities held to maturity decreased $13.0 million, or 3.7%, to $340.2 million at September 30, 2018 from $353.2 million at June 30, 2018. This decrease was primarily caused by $8.0 million in amortization of mortgage-backed securities, net of purchases, and $5.0 million of net maturities of U.S. government and agency obligations.

Securities Available for Sale. Total securities available for sale decreased $4.0 million, or 3.7%, to $101.5 million at September 30, 2018 from $105.5 million at June 30, 2018. This decline was primarily due to $2.0 million of net maturities of U.S. government and agency obligations, $1.8 million of amortization of mortgage backed securities, net of purchases, and a $153,000 increase in net unrealized losses primarily attributable to an increase in market interest rates.

Net Loans Receivable. Net loans receivable increased $2.8 million, or 0.3%, to $905.1 million at September 30, 2018 from $902.3 million at June 30, 2018. The increase was the result of $33.2 million of originations, partially offset by $30.4 million of net amortization and prepayments on the remaining portfolio, including two commercial mortgage loans totaling $10.2 million.

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Deposits. Total deposits decreased $4.3 million, or 0.4% to $1.15 billion at September 30, 2018 from $1.16 billion at June 30, 2018. This decrease primarily reflects decreases of $40.3 million in savings, and $859,000 in demand deposits, partially offset by increases of $29.4 million in money market accounts, $3.8 million in time deposits and $3.6 million in NOW accounts. The decrease in total deposits was primarily attributable to expected seasonal outflows related to school and property tax payments.

Federal Home Loan Bank Advances. Federal Home Loan Bank advances remained unchanged from the prior quarter at $18.8 million as of September 30, 2018.

Total Shareholders’ Equity. Total shareholders’ equity increased $2.3 million, or 0.8%, to $289.9 million at September 30, 2018 from $287.6 million at June 30, 2018. This increase was primarily due to net income of $2.3 million and a $493,000 reduction in unearned ESOP shares for plan shares earned during the period, partially offset by $505,000 of cash dividends paid in the current quarter. At September 30, 2018, the Company’s book value per share was $15.96, compared to $15.83 at June 30, 2018. At September 30, 2018, the Bank was considered “well capitalized” under applicable regulatory guidelines.

Comparison of Operating Results for the Three Months Ended September 30, 2018 and 2017

General. Net income increased $573,000, or 32.6%, to $2.3 million for the three months ended September 30, 2018 compared to $1.8 million for the three months ended September 30, 2017. The increase was primarily due to a $588,000 increase in net interest income, a $95,000 decrease in income tax expense and a $77,000 decrease in the provision for loan losses, partially offset by a $114,000 increase in non-interest expense and a $73,000 decrease in non-interest income.

Net Interest Income. Net interest income increased $588,000, or 6.0%, to $10.5 million for the three months ended September 30, 2018 compared to a $9.9 million for the three months ended September 30, 2017. The increase primarily reflects a $55.4 million increase in average interest-earning assets and a 5 basis point increase in the net interest margin to 2.94% for the three months ended September 30, 2018 compared to 2.89% for the three months ended September 30, 2017. The increase in average net interest-earning assets primarily reflects the loan portfolio growth, partially offset by a decrease in investment securities.

Interest and Dividend Income. Interest and dividend income increased $1.3 million, or 11.6%, to $12.6 million for the three months ended September 30, 2018 compared to a $11.3 million for the three months ended September 30, 2017. The increase primarily reflects a $55.4 million increase in total average interest-earning assets and a 24 basis point increase in the yield on total interest-earning assets. The increase in yield is due to the increase in market interest rates, as well as the shift from generally lower yielding investment securities to generally higher yielding loans.

Interest income on loans receivable increased $1.1 million, or 12.2%, primarily due to an $89.8 million increase in the average balance of loans receivable to $903.0 million for the three months ended September 30, 2018 from $813.2 million for the same period last year, and a 5basis point increase in the average yield on loans to 4.38% for the three months ended September 30, 2018 from 4.33% for the same period last year.

Interest income on securities increased $121,000, or 5.4%, primarily due to a 24 basis point increase in the average yield on securities to 2.09% for the three months ended September 30, 2018 from 1.85% for the same period last year, partially offset by a $32.4 million decrease in the average balance of securities. The increase in the yield on securities was primarily due to an increase in market interest rates.

Interest Expense. Interest expense increased $724,000, or 51.0%, to $2.1 million for the three months ended September 30, 2018 compared to $1.4 million for the three months ended September 30, 2017. The increase primarily reflects a 25basis point increase in the average cost to 0.81% for the three months ended September 30, 2018 from 0.56% for the same period last year, and $49.2 million increase in the average balance on interest bearing liabilities.

Interest expense on interest-bearing deposits increased $789,000, or 62.3%, primarily due to a 27 basis point increase in the average cost of deposits to 0.79% for the three months ended September 30, 2018 from 0.52% for the same period last year, and a $71.8 million increase in the average balance to $1.03 billion for the three months ended September 30, 2018 from $961.1 million for the three months ended September 30, 2017. The increase in the average rate paid on interest-bearing deposits was caused primarily by a 66 basis point increase in the average rate

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paid on money market accounts, and a 43 basis point increase in the average rate paid on time deposits as the Bank offered increased rates on these deposits due to the increase in market rates.

Interest expense on Federal Home Loan Bank advances decreased $65,000, or 42.2%, primarily due to a $22.6 million decrease in the average balance to $18.8 million for the three months ended September 30, 2018 from $41.4 million for the same period last year, partially offset by a 41 basis point increase in the average cost to 1.89% for the three months ended September 30, 2018 from 1.48% for the same period last year. The increase in the average cost is primarily due to the maturity of lower cost borrowings.

Provision for Loan Losses. The provision for loan losses decreased by $77,000 to $58,000 for the three months ended September 30, 2018, compared to $135,000 for the three months ended September 30, 2017. Charge-offs, net of recoveries, were $3,000 for the three months ended September 30, 2018 compared to charge-offs, net of recoveries, of $17,000 for the three months ended September 30, 2017.

Non-Interest Income. Non-interest income decreased $73,000, or 10.2% to $641,000 for the three months ended September 30, 2018 compared to a $714,000 for the three months ended September 30, 2017. The decrease was caused primarily by $173,000 of gains on sale of securities recorded in the prior year period, partially offset by $71,000 of swap fee income and increases in deposit-related fees in the current quarter.

Non-Interest Expense. Non-interest expense increased $114,000, or 1.4%, to $8.0 million for the three months ended September 30, 2018 compared to $7.9 million for the three months ended September 30, 2017. The increase was caused primarily by a $280,000 increase in salaries and employee benefits, partially offset by decreases of $78,000 in advertising, $44,000 in professional fees, $41,000 in occupancy and equipment, and $3,000 in all other operating expenses. The increase in salaries and employee benefits was primarily due to additional staffing, partially offset by lower retirement and medical benefits costs.

Income Tax Expense. Income tax expense decreased $95,000, or 11.8%, to $710,000 for the three months ended September 30, 2018 from $805,000 for the three months ended September 30, 2017. The decrease was caused primarily by the Company fully realizing the benefits of the reduction in the Federal corporate income tax rate from 34% to 21%, which became effective in January 2018. The effective income tax rate was 23.4% for the three months ended September 30, 2018 compared to 31.4% for the three months ended September 30, 2017.

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Net Interest Income

Average Balance Sheet and Interest Rates. The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Nonaccrual loans are included in average balances only. Amortization of loan fees is included in interest income on loans.

	Three Months Ended September 30,
	2018								2017
	Average Balance			Interest/ Dividends		Average Rate			Average Balance			Interest/ Dividends		Average Rate
	(dollars in thousands)
Assets:
Loans receivable	$	903,021		$	9,898		4.38	%	$	813,244		$	8,818		4.33	%
Securities		453,671			2,366		2.09			486,026			2,245		1.85
Other interest-earning assets		67,222			345		2.03			69,257			234		1.34
Total interest-earning assets		1,423,914			12,609		3.54			1,368,527			11,297		3.30
Non-interest-earning assets		49,894								58,241
Total assets	$	1,473,808							$	1,426,768
Liabilities and equity:
NOW accounts	$	119,404			53		0.18		$	114,770			49		0.17
Money market accounts		58,704			139		0.94			30,100			21		0.28
Savings accounts and escrow		462,542			289		0.25			518,315			325		0.25
Time deposits		392,336			1,575		1.59			298,010			872		1.16
Total interest-bearing deposits		1,032,986			2,056		0.79			961,195			1,267		0.52
Federal Home Loan Bank advances		18,821			89		1.89			41,398			154		1.48
Total interest-bearing liabilities		1,051,807			2,145		0.81			1,002,593			1,421		0.56
Non-interest-bearing deposits		125,381								134,368
Other non-interest-bearing liabilities		7,281								8,287
Total liabilities		1,184,469								1,145,248
Total equity		289,339								281,520
Total liabilities and equity	$	1,473,808							$	1,426,768
Net interest income				$	10,464							$	9,876
Interest rate spread (1)							2.73								2.74
Net interest margin (2)							2.94								2.89
Average interest-earning assets to interest-bearing liabilities		135.38	%							136.50	%

⁽¹⁾ Net interest rate spread represents the difference between the average yield on average interest-earning assets and the average cost of average interest-bearing liabilities.

⁽²⁾ Net interest margin represents annualized net interest income divided by average interest-earning assets.

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Rate/Volume Analysis. The following tables set forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. Changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

	Three Months Ended September 30,
	2018 versus 2017
	Rate			Volume			Net
	(in thousands)
Interest income:
Loans receivable	$	84		$	996		$	1,080
Securities		248			(127	)		121
Other interest-earning assets		119			(8	)		111
Total interest-earning assets		451			861			1,312
Interest expense:
NOW accounts		2			2			4
Money market accounts		84			34			118
Savings and escrow accounts		8			(44	)		(36	)
Time deposits		380			323			703
Federal Home Loan Bank advances		35			(100	)		(65	)
Total interest-bearing liabilities		509			215			724
Net (decrease) increase in net interest income	$	(58	)	$	646		$	588

Management of Market Risk

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans and investment securities, have longer maturities than our liabilities, consisting primarily of deposits and FHLB advances. As a result, a principal part of our business strategy is to manage our exposure to changes in market interest rates. Accordingly, we have established a management-level Asset/Liability Management Committee, which takes initial responsibility for developing an asset/liability management process and related procedures, establishing and monitoring reporting systems and developing asset/liability strategies. On at least a quarterly basis, the Asset/Liability Management Committee reviews asset/liability management with the Investment Asset/Liability Committee that has been established by the Board of Directors. This committee also reviews any changes in strategies as well as the performance of any specific asset/liability management actions that have been implemented previously. On a quarterly basis, an outside consulting firm provides us with detailed information and analysis as to asset/liability management, including our interest rate risk profile. Ultimate responsibility for effective asset/liability management rests with our Board of Directors.  

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. The net proceeds from the offering have increased our capital and provided management with greater flexibility to manage our interest rate risk, including the following strategies: originating loans with adjustable interest rates; promoting core deposit products; and adjusting the interest rates and maturities of funding sources, as necessary. By following these strategies, we believe that we are better positioned to react to changes in market interest rates.  

Net Portfolio Value Simulation. We analyze our sensitivity to changes in interest rates through a net portfolio value of equity (“NPV”) model. NPV represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities. The NPV ratio represents the dollar amount of our NPV divided by the present value of our total assets for a given interest rate scenario. NPV attempts to quantify our economic value using a discounted cash flow methodology while the NPV ratio reflects that value as a form of equity ratio. We estimate what our NPV would be at a specific date. We then calculate what the NPV would be at the same date throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in

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the yield curve. We currently calculate NPV under the assumptions that interest rates increase 100 and 200 basis points from current market rates and that interest rates decrease 100 and 150 basis points from current market rates.

The following table presents the estimated changes in our NPV that would result from changes in market interest rates at September 30, 2018 and June 30, 2018. All estimated changes presented in the table are within the policy limits approved by our Board of Directors.

	NPV									NPV as Percent of Portfolio Value of Assets
	(dollars in thousands)
Basis Point Change in Interest Rates	Dollar Amount		Dollar Change			Percent Change				NPV Ratio			Change (in bps)
September 30, 2018:
200	$	301,482	$	(40,505	)		(11.8	)	%		22.03	%		(159	)
100		323,592		(18,395	)		(5.4	)			22.97			(65	)
-		341,987	-			-					23.62		-
(100)		351,356		9,369			2.7				23.68			6
(150)		354,636		12,649			3.7				23.65			3
June 30, 2018:
200	$	282,017	$	(50,676	)		(15.2	)	%		20.75	%		(219	)
100		313,606		(19,087	)		(5.7	)			22.25			(69	)
-		332,693	-			-					22.94		-
(100)		342,520		9,827			3.0				23.02			8
(150)		348,648		15,955			4.8				23.14			20

Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The above table assumes that the composition of our interest-sensitive assets and liabilities existing at the date indicated remains constant uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our NPV and will differ from actual results.

Liquidity and Capital Resources

Liquidity. Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

We regularly review the need to adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short and intermediate-term securities.

Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At September 30, 2018, cash and cash equivalents totaled $68.3 million, an increase from $62.1 million as of June 30, 2018. Securities classified as available for sale, which provide an additional source of liquidity, totaled $101.6 million at September 30, 2018, a decrease from $105.5 million as of June 30, 2018.

We had the ability to borrow up to $301.4 million and $314.9 million from the Federal Home Loan Bank of New York, at September 30, 2018 and June 30, 2018, respectively, of which $18.8 million was outstanding as of September 30, 2018 and June 30, 2018, respectively. We also had an available line of credit with the Federal Reserve Bank of New York’s discount window program of $118.3 million and $122.1 million as of September 30, 2018 and June 30, 2018, respectively, none of which was outstanding at either date.

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We have no material commitments or demands that are likely to affect our liquidity other than as set forth below. If loan demand was to increase faster than expected, or any unforeseen demand or commitment was to occur, we could access our borrowing capacity with the Federal Home Loan Bank of New York or the Federal Reserve Bank of New York.

We had $92.2 million and $99.7 million of loan commitments outstanding as of September 30, 2018 and June 30, 2018, respectively, and $65.2 million and $59.5 million as of September 30, 2018 and June 30, 2018, respectively, of approved, but unadvanced, funds to borrowers. We also had $1.6 million and $1.4 million in outstanding letters of credit at September 30, 2018 and June 30, 2018, respectively.  

Time deposits due within one year of September 30, 2018 totaled $180.5 million, a decrease of $2.8 million from $183.3 million as of June 30, 2018. If these deposits do not remain with us, we will be required to seek other sources of funds, including other time deposits and Federal Home Loan Bank of New York advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the time deposits at September 30, 2018. We believe, however, based on past experience that a significant portion of our time deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

The Company is a separate legal entity from the Bank and must provide for its own liquidity to pay any dividends to its stockholders and for other corporate purposes. The Company’s primary source of liquidity is dividend payments it may receive from the Bank. The Bank’s ability to pay dividends to the Company is governed by applicable laws and regulations. At September 30, 2018, the Company (on an unconsolidated, stand-alone basis) had liquid assets of $71.1 million.

Capital Resources. The Company and Bank are subject to various regulatory capital requirements administered by the New York State Department of Financial Services and the Federal Deposit Insurance Corporation. At September 30, 2018, the Bank exceeded all applicable regulatory capital requirements, and was considered “well capitalized” under regulatory guidelines. See Note 9 to the accompanying unaudited financial statements

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The information required by this item is included in Part I, Item 2 of this report under "Management of Market Risk".

Item 4. Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2018. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Registrant’s disclosure controls and procedures were effective.

During the quarter ended September 30, 2018, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. will not have a material impact on the Company’s consolidated financial position, results of operations or disclosures

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company is not involved in any pending legal proceedings as a plaintiff or a defendant other than routine legal proceedings occurring in the ordinary course of business. At September 30, 2018, the Company was not involved in any legal proceedings the outcome of which it believes would be material to its consolidated financial condition or results of operations.

Item 1A. Risk Factors

For information regarding the Company’s risk factors, see Part 1, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended June 30, 2018, filed with the Securities and Exchange Commission. As of September 30, 2018, the risk factors of the Company have not changed materially from those disclosed in the Annual Report on Form 10-K for the year ended June 30, 2018.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds of Registered Securities

None

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit Number	Description
3.1	Articles of Incorporation of PCSB Financial Corporation (1)
3.2	Bylaws of PCSB Financial Corporation (2)
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32	Certification of Chief Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(3)
101	The following materials for the quarter ended September 30, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements (3)

(1) Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended (Commission File No. 333-215052).

(2) Incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1, as amended (Commission File No. 333-215052).

(3) Furnished, not filed.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PCSB FINANCIAL CORPORATION
Date:  November 9, 2018	/s/ Joseph D. Roberto
	Joseph D. Roberto
	Chairman, President and Chief Executive Officer
Date:  November 9, 2018	/s/ Scott D. Nogles
	Scott D. Nogles
	Executive Vice President and Chief Financial Officer

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